Ian Cowie was named Consumer Affairs Journalist of the Year in the
London Press Club Awards 2012. He has been head of personal finance at
Telegraph Media Group since 2008, having been personal finance editor
since 1989. He joined the paper in 1986. He is @iancowie on Twitter.

Australian floods boost commodity prices, shares and funds

After 12 people have died and dozens remain missing in the worst floods to hit Australia for decades, you might well think it is in the worst possible taste to consider the financial consequences of this natural disaster. But the fact remains that Queensland is the source of more than half the global supply of hard coking coal, which is vital for making steel. Most of these mines are now underwater or cut off from the coast because floods have washed away rail links. This part of Australia also used to produce more than a third of the world’s seaborne trade in semi-soft coking coal, according to Goldman Sachs.

No wonder the disaster has fuelled further price increases in these commodities, which had already risen sharply as China and other emerging economies’ demand for the raw materials of industrialisation gathered pace. British investors in commodities-based shares, unit and investment trusts have benefited from that trend and the question now is whether it has further to go.

While the investment and unit trust both delivered total returns of about 130 per cent over five years, BHP Billiton is up by 192 per cent. Even after recent price increases, the shares continue to yield more than 2 per cent net of basic rate tax while the funds pay negligible dividends. At this stage, I had better declare an interest and point out that I hold BHP Billiton in my self invested personal pension (SIPP).

Investing in a single company’s shares is more dangerous than buying an investment or unit trust which reduces risk by spreading investors’ money over dozens of different shares and limits their exposure to setbacks at any one company, country or commodity. Stephen Peters, investment trust analyst at the stockbroker Charles Stanley, pointed out that BlackRock World Mining shares are still trading at a discount of more than 14 per cent to the net asset value of this investment trust.

He added: “Blackrock World Mining is the purest way of accessing the global resources theme. The supply and demand profile for natural resources globally, and especially in China, remains strong and as such the long term outlook for commodities remains positive, in the view of the fund manager, Evy Hambro.

“We think the managers are good, although believe that the trust should be seen as a way of investing in a theme. The trust's discount volatility can be considerable – this seems to be a function of the level of optimism or pessimism over the sector in the market, with investors buying the trust at times of uncertainty and selling when returns from the wider sector are strong.”

But Gavin Haynes of independent financial advisers (IFAs) Whitechurch Securities warned of the dangers in chasing financial fashion. He said: “Commodities prices have performed strongly for much of the past decade and this has resulted in strong investment returns in many areas associated with natural resources. Following such a prolonged period of performance it is natural to be cautious and it is important to be aware that this is a highly cyclical investment area.

“However, there are a number of factors pointing towards a long-term upward price trend in many commodities driven by a supply and demand imbalance. China and other emerging markets continue to show strong demand, whilst the recent price rises in coal illustrate how limited supply and the effect that supply shocks can have on the price.

“I would stress that this is a highly specialist area and I would recommend that investors only invest a maximum of 5 per cent of a portfolio and must be comfortable with a high level of volatility.”

Darius McDermott at Chelsea Financial Services was also cautious. He said: “I would be wary about investing in a theme on a short term supply-demand imbalance; especially if you couple that with the strong performance of the sector over a number of years now.

“The case for investing in mining is still based on strong Chinese growth and the continuing urbanisation of emerging markets. Probably a sensible way to play commodities generally is in a fund like JPM Natural Resources which also invests in gold, other metals and oil.”

Another factor to consider is that many investors in general funds will already have indirect exposure to commodities because of mining shares now represent a substantial portion of the total value of shares traded on major stock exchanges. So there may be no need to buy a specialist fund and those who do so could even run the risk of having too many eggs in one basket.

Mark Dampier of Hargreaves Lansdown explained: “Remember you are likely to be aboard this bandwagon already, as the FTSE100 is 15 per cent comprised of mining shares.

“As a result, many investors have a highly correlated portfolio without realising it – which has disturbing shades of 2000 about it when many investors discovered they had too much exposure to technology, media and telecommunications (TMT) shares.

“I still like the long term story for rising demand and rising prices in the commodities sector but investors should be careful.”

That is an important point to make as figures from the Investment Management Association this week showed record inflows into commodity funds. Out of a total of £1.4bn net investment in unit trusts and open-ended investment companies (OEICs) in November, about £208m went into commodity funds.

Cynics will say this is a sure sign that a bubble is being inflated to near bursting point and that the fun cannot last much longer. But bears have been saying that for some time – and they have been wrong so far.

Either way, nobody can accuse Mr Hambro, manager of BlackRock World Mining, of trying to talk the price up. He said: "The commodities market is becoming increasingly supply constrained, particularly copper and coal. The flooding in Australia is only going to accentuate this, which might provide some opportunity for investors in the short term.

“There will be an impact on companies who can’t produce, and those who are able to get their product out will benefit. But essentially the flooding will be resolved, so I don't see any long term impact."